Previously published on March 24, 2023 in
By Milton Ezrati, Chief Economist at Vested
President Joe Biden’s budget predictably has sparked intense debate. Opinions on overall spending, taxes, equity, and deficits fill financial columns.
To see what is happening to the nation’s finances, it helps to step away from these politically motivated criticisms and praise of the president’s proposals and instead look at the basic structure of government finances. There, it becomes clear that no small modification can make a difference in the picture of growing deficits. Nor can worries over “fair shares” or efforts to trim waste brighten the financial picture appreciably (though such questions are imperative in other respects).
To make substantive progress, the issue is entitlements. It has been for years. Without reform in this politically sensitive area, deficits will expand inexorably and the nation’s finances will continue to weaken.
As of 2022, entitlements spending—Social Security, Medicare, Medicaid, unemployment insurance, and the like—equaled fully two-thirds of all federal spending. This spending absorbed 16.5 percent of the nation’s gross domestic product (GDP). By contrast, the next largest part of the budget, defense spending, took down about one-eighth of all federal spending, about 3 percent of GDP.
Entitlements spending has long overwhelmed the budget. It has consistently outgrown federal revenues and other sorts of spending, more than doubling its share of GDP from an already significant 7.6 percent of GDP in 1970 to today’s huge percentage.
This expansion has more than offset the relative drop in defense spending during this time from 7.8 percent of GDP in 1970 to less than half that proportion today. Accordingly, federal outlays overall have risen from 18.7 percent of GDP in 1970 to 25.1 percent last year.
Part of the problem with Social Security, Medicare, and these other line items is that the costs of these services, especially medical, have risen faster than most other economic costs.
Also, Washington has consistently enriched these programs—expanding Medicaid, for example—extending subsidies under the Affordable Care Act, and giving Social Security a generous inflation index scheme, just to name three of the more significant actions. If student debt forgiveness passes constitutional muster, it will expand such commitments further. Though in a strict accounting sense, debt forgiveness doesn’t count as an entitlement.
Even if Washington resists the temptation to add still more generous programs of these sorts, the nation’s demographic prospects make clear that such spending will outgrow the rest of the budget and the economy. The huge baby boom generation is retiring. The number of dependent retirees will continue to grow in the coming years. In 1970, for example, some 10 percent of the population was 65 years old or older. By 2019, that figure had grown to 16 percent.
The Census Bureau estimates that by the mid-2030s, that figure will rise to 21 percent. This huge proportion of older people can’t help but increase demands for Social Security, Medicare, and other federal services and greatly accelerate the absolute and relative growth in entitlements spending.
None of this is to say that entitlements, large as they are relative to all federal spending and the economy generally, are the wrong way for Washington to spend. The trends, historic and prospective, reflect priorities voted for by Congresses of both parties and signed into law by Democratic and Republican presidents alike. Perhaps this is how the nation should allocate its output of goods and services. That is a political judgment.
Economics can only point out the financial realities of that political judgment. And since entitlements, structured as they are, will continue to outpace other aspects of the budget, economics can give Washington only three options, none politically easy.
First, the political establishment can get control over entitlements, at least enough to moderate their rapid growth rate.
Second, Washington can accommodate the ever-increasing demands of entitlements by sacrificing other government services, as was partially done with defense in the past but which no longer looks possible in today’s geopolitical climate.
Third, Washington can simply tell the voters that they must pay more taxes so that their representatives don’t have to make these other difficult decisions.
There is, of course, always the hope that economic growth will accelerate, making the nation so wealthy that it can easily support the current trends in entitlements spending. Washington can also hope that inflation remains high. That would, of course, hurt the average American. But inflation tends to benefit debtors, and Washington, as the largest debtor of all, would benefit.
Even if one of these events eases some immediate financial pressures, budget basics would remain the same and demand economic and financial realism in Washington. Sadly, given history, financial realism seems as likely as a sunrise in the west.